Newly Unsealed Documents Show How Treasury Violated HERA

The more that is known about the thinking and discussions in the inner sanctums of government during the course of the conservatorship of Fannie Mae and Freddie Mac, the more obvious it is that Treasury officials exceeded their legal authority in order to hasten the dismantlement of the enterprises.

In addition to setting up a process by which the assets of Fannie and Freddie would be conserved and preserved, the Housing and Economic Recovery Act (HERA) explicitly delineated the powers and duties of the Federal Housing Finance Agency (FHFA) as conservator and constricted Treasury’s powers. Top government officials intimately involved with the drafting of the statute have detailed how Congress made it a point to reinforce the independence of FHFA as the conservator, consistent laws dealing with distressed institutions going back decades. But this seemed to have little bearing on Treasury’s determination to dictate Fannie and Freddie’s fate, which ultimately led to the Net Worth Sweep in 2012 and the depletion of their capital.

For example, Jim Parrott, who was a top housing policy advisory at the White House at the time of Sweep, was asked in a deposition whether there had been outreach to Congress about the Sweep. He replied that he had not done so and commented “…this was a Treasury-driven process. So to the degree there was outreach to the Hill, it would have come from Treasury, and not from, from me.”

Parrott’s name has surfaced in several documents unsealed this spring. Recall one of them was his email to senior officials at Treasury the day the Sweep was announced, boasting that diverting Fannie’s and Freddie’s profits would eliminate “the possibility that they ever go (pretend) private again.”

Treasury’s assertion of de facto control came early in the conservatorship. A heavily-redacted presentation prepared by PriceWaterhouseCoopers for Freddie to FHFA in October 2008, explained that the Preferred Stock Purchase Agreement terms “restrict the business activities” of Freddie and prevents the company from taking various steps in its own management “without prior written consent of Treasury.” Thus, the designated conservator was told early on that the buck stops with Treasury, regardless of what the statute said.

This interest by Treasury to keep Fannie and Freddie on a short leash is also evident in a draft document spelling out the terms of the PSPA s prepared for Treasury in August 2008 by the law firm of Wachtel, Lipton, Rosen and Katz and Morgan Stanley, in their capacity as independent consultants. In the section of that document titled “Transfers of Assets” the ability of the GSEs to sell assets without Treasury’s consent is restricted. The document also reveals Treasury’s long-term calculations on the value of the warrants the government received for Fannie and Freddie’s stock. Ultimately, these terms would make it impossible for Fannie and Freddie to pay back public funds made available to them at the start of the conservatorship.

Other documents from the early months of the conservatorship provide yet more information that Ed DeMarco had been on a quest to assist Treasury in using the conservatorship to dismantle Fannie and Freddie practically from the outset. In a presentation in November 2008 to other government officials, DeMarco, then a deputy director at FHFA, said “…conservatorship is a legal process to stabilize a troubled institution with the objective of returning the GSEs to normal business operations. Structure was flawed.” Thus he knew the statute said one thing (restore their financial footing) but he believed it was better policy to do something else (wind them down.)

On top of these documents is a March 2012 memo from Deloitte that observes that with Fannie and Freddie in conservatorship, “…the US government, and the US Treasury continue to be able to direct the Company’s business.” Interestingly, a September 2008 memo from Freddie’s auditor, PriceWaterHouseCoopers, says “Treasury’s authority to purchase GSE debt obligations and securities will expire on December 31, 2009.” As we now know, that deadline meant nothing as Treasury engineered the Sweep in the summer of 2012.

All this serves to underscore an important claim by shareholders who have challenged the Net Worth Sweep: Treasury controls the GSEs and FHFA’s role as independent conservator was rendered meaningless from the start of the conservatorship. As the discovery process yields more information it is a safe bet that more violations of HERA will come to light. When they do, the rationale for the Sweep will crumble and the injustice suffered by shareholders will be glaringly apparent.